Pretty broad question, but I hear these things thrown around a lot and was wondering if such a canonical or straightforward definition exists.

To make this simple:

What makes an investor "smart" as opposed to "not smart?" I know it can't be risk because high-risk doesn't mean dumb, and low-risk doesn't mean smart necessarily either. I'd like to know how one can apply "smart" or "dumb" to investors/investing, and how those words could be applied to investment choices and decisions in a broad sense.

Also, people use the word "successful," but success is pretty subjective. Success to the people who witness the investor's choices and outcomes -- or success felt by the investor themselves?

Success to one person may be drastically different to another -- so where does "success" come in to with investing? For example, someone investing in an index fund might feel successful in 20 years -- but another person might feel like they wasted the time and opportunities to leverage with higher risks.

  • 1
    Can you give us an example of somewhere that these terms were used that confused you? – Ben Miller - Remember Monica Mar 2 '17 at 12:32
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    As an addendum to my answer, I offer advice that I hope you will take well: you have tagged your question as 'leveraging'. While leverage is an important financial concept to understand, it is not directly relevant to the discussion at hand. That implies to me, perhaps, that you might be trying to highlight your own understanding of investing, by using the 'right words'. Never trick yourself into thinking you are an expert, simply because you use these words. Saying them is not the same as understanding what they mean. Everyone always has room to learn, and humility helps us remember this. – Grade 'Eh' Bacon Mar 2 '17 at 14:59

This question is quite broad, but I think you are on the right track that 'risk' does not equal 'intelligence', one way or the other.

I think the most basic answer to your question is simply that a 'smart' investor understands the risks they take on, and how those risks are associated with opportunities. You are correct that some people have a higher risk appetite than others, so taking on additional risk does not necessarily imply they are 'dumb'. Likewise, as you say, some people have a low risk appetite, and taking on minimal risk does not simply mean they are 'smart'. However, if someone takes on a high amount of risk, and is not aware of it, that is not 'smart'.

As an analogy, imagine 4 people walk into a casino. A 'smart' high-risk investor, a 'dumb' high-risk investor, a 'dumb' low-risk investor, and a 'smart' low-risk investor.

(1) The smart high-risk investor is a very good blackjack player, and understands how to play the game to get a slight edge on the casinos (assume that knowing how to play blackjack perfectly yields a win-rate of... 51%). They are taking on a lot of risk, but they are aware of that risk, and accept the highs with the lows, expecting to be compensated in the end by proper play.

(2) The dumb high-risk investor goes to the roulette wheel. There is no skill in roulette, but this investor believes he has created a 'special system' that means he can win if he places the correct bets. But, a roulette bet always only has a win-rate of something like 45%. They 'know' they are taking on risk, but cannot assess it properly, and make poor judgment causing them to lose money on average.

(3) The dumb low-risk investor goes to the blackjack table, because they have heard that blackjack is the only game that has odds in favour of the gambler. But, they don't know how to play perfectly, and they also don't understand that while such an edge is possible, it exists with a very high degree of risk. Thus, they also take on more risk than they wanted, and lose money on average.

(4) The smart low-risk investor goes to the buffet, and watches a show. They know that gambling is high risk, and they know that they would lose, on average, on any bet they make, so they just don't play [assume that while making money on average at blackjack may be possible with perfect play, this person isn't confident in their own skills, and doesn't find that level of risk acceptable anyway].

This is a simplification, of course, and it limits the full scope of discussion, but it may help you to look for 'smartness' not just in the outcomes of someone's strategy, or the risk, but the way they approach it. If you look closely, you can see some examples of the above basic types on this very question site. There are people with hare-brained get-rich-quick questions, and people throwing money away for no reason because they afraid of the possibilities they don't understand. There are people with aggressive strategies who understand they are aggressive, and there are people with low-risk strategies who accept that their gains will be less on average than their peers.

Finally, note that I have not addressed 'success', which is simply the measurement of achievement of one's goals, whatever those may be. Success to one person is retirement in the Hamptons, and to another person it is a low-stress stable job that gives them time to spend with family.


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